Thank You Ethanol

Bangladeshi demonstrators chant slogans
against high food prices during weekend protests.

People stand near the ruins of a gas station after recent
rioting over high food prices near Port-au-Prince, Haiti.

• CNN – Riots, instability spread as food prices skyrocket
  Riots from Haiti to Bangladesh to Egypt over the soaring costs of basic foods have brought the issue to a boiling point and catapulted it to the forefront of the world’s attention, the head of an agency focused on global development said Monday. . . . In the United States and other Western nations, more and more poor families are feeling the pinch. In recent days, presidential candidates have paid increasing attention to the cost of food, often citing it on the stump. The issue is also fueling a rising debate over how much the rising prices can be blamed on ethanol production. The basic argument is that because ethanol comes from corn, the push to replace some traditional fuels with ethanol has created a new demand for corn that has thrown off world food prices.

• The New York Times – Finance Ministers Emphasize Food Crisis Over Credit Crisis
  The world’s economic ministers declared on Sunday that shortages and skyrocketing prices for food posed a potentially greater threat to economic and political stability than the turmoil in capital markets.

• The Wall Street Journal – Russian Oil Slump Stirs Supply Jitters
  Russian oil production, for years a vital source of new supplies for world markets, is showing signs of a slump, adding to uncertainties that have helped push oil prices to record highs. Russian output fell for the first time in a decade in the first three months of this year, according to the International Energy Agency, which represents industrialized oil-consuming countries. It said Russian production averaged about 10 million barrels a day, a 1% drop from the first-quarter of 2007.

• The New York Times – Fuel Choices, Food Crises and Finger-Pointing
  The idea of turning farms into fuel plants seemed, for a time, like one of the answers to high global oil prices and supply worries. That strategy seemed to reach a high point last year when Congress mandated a fivefold increase in the use of biofuels. But now a reaction is building against policies in the United States and Europe to promote ethanol and similar fuels, with political leaders from poor countries contending that these fuels are driving up food prices and starving poor people. Biofuels are fast becoming a new flash point in global diplomacy, putting pressure on Western politicians to reconsider their policies, even as they argue that biofuels are only one factor in the seemingly inexorable rise in food prices.

Comment We warned as far back as November 2006 that ethanol was a bad idea:

We have commented on several occasions, most recently in a September Commentary, at how minimal the damage to both the economy and financial markets has been from higher petroleum prices. These prices were pulled higher by stronger economic growth.

The distortions produced by an ill-considered move into ethanol will not be as pain-free. We have gone three decades without significant food price inflation. No one appeared to miss its presence. Why resume the experience now?

We re-iterated this warning in January 2007:

Our collective fear of uttering the words, “It’s different this time,” is high enough to prevent us from doing so when the facts warrant.

A reading of history would leave us sanguine; yes, old crop corn is moving higher and the inversion to December is growing as well. We have seen worse and survived.

Yet the ethanol market is a new and major source of demand for corn. We have no experience in the corn market equivalent of a bought deal, wherein a non-food industry can outbid the food industry for food. We do have experience with government interference in both agricultural and energy markets, all of which can be summarized as “not good.” That will not be different this time.

And again in February 2007:

Subsidies such as the 51¢ per gallon motor fuel excise tax holiday for ethanol and the 54¢ per gallon tariff on imports of Brazilian sugar-derived ethanol have distorted agricultural economics already. Further market distortions are going to be addressed with further subsidies for farmers and distillers and by the political allocation of corn between the food and energy markets if supplies become stressed.

To-date, the macroeconomic and financial market damage has been contained. This will not always be the case. The price controls and mandatory allocations of the 1970s helped create a decade of malaise. Why revisit that unhappy era?